While banks and companies can tell investors what they will pay, mutual funds cannot declare the 'yield' on close-ended debt schemes. They were earlier also barred from disclosing the indicative portfolio of these schemes.

However, the Securities and Exchange Board of India last year allowed close-ended debt schemes to disclose instruments in which they proposed to invest as well as floors and ceilings within 5 per cent range of the intended allocation. The aim was to help investors arrive at the return they could expect.

FMPs are close-ended fixed maturity schemes that invest in debt securities such as treasury bills (T-bills) commercial papers (CPs), certificates of deposit (CDs), and government and corporate bonds.

Close-ended funds are open for subscription for a limited period. The investor cannot sell the units to the fund house before maturity. However, he can sell to others on exchanges.

CALCULATING INDICATIVE YIELD

An FMP's offer document should mention instruments in which the scheme plans to invest and in what proportion, plus their credit quality and yields.

Take a three-month FMP which was open for sale on 19-20 March 2012. The offer document gave the following disclosures:

The scheme's tenure is 91 days. Close-ended debt funds cannot invest in securities with maturity period of more than the scheme's tenure.

It is clear that the scheme will invest 95-100 per cent money in CPs with A1+ or equivalent rating. CPs are issued by companies to raise money for the short term (less than a year).

Table (Prevailing Yields) shows that the current yield on CPs with A1+ or equivalent rating is 11.45-11.55 per cent.

Assuming the fund manager keeps 5 per cent funds as cash and invests the rest 95 per cent in CPs, which are offering 11.45 per cent, the likely annual return will be 10.88 per cent (11.45X0.95).

Fund houses charge a fee to cover expenses. The maximum they can charge in a year is 2.25 per cent of the fund's average net asset value. However, they rarely charge so much. To determine this, you can check the fee being charged on existing FMPs of the fund house. If it is not available, use the average expense ratio of existing FMPs, which at present is 0.4 per cent.

If we deduct this (0.4 per cent) from the return figure of 10.88 per cent, the likely annual return from the FMP, if held till maturity, will be close to 10.5 per cent. Therefore, the three-month FMP will pay 2.625 per cent (10.5/4).

A MORE DIVERSE PORTFOLIO

In the earlier example, the scheme invested only in one type of security, that is, CPs. Let's figure out the indicative yield of an FMP with a slightly more diverse portfolio.

An FMP buys securities with durations similar to its own tenure to minimise the reinvestment risk.

Let's consider a 370-day FMP which will invest in the following securities:

In the given example, the tenure of the scheme is 370 days, that is, just over a year (365 days).

The scheme will invest 95-100 per cent in NCDs with 9.95-10 per cent yield.

From the indicative yield calculated earlier, deduct the expense ratio (0.40 percentage points) to arrive at the approximate yield the FMP may generate.

In the example, the annual indicative yield will be close to 9.5 per cent.

ROUGH ESTIMATION

These are a rough estimate of what you can expect.

"The yields on most instruments and their ratings are available in business dailies. They need to be adjusted for expenses of the fund. A challenge is that these expenses tend to be in a range that can be quite wide," says Vishal Dhawan, CEO and chief financial planner, Plan Ahead Wealth Advisors.

To know the exact yield, you can check with distributors/agents selling these products."Most institutional investors active in the debt market can estimate this return accurately," says Sanjay Sinha, founder, Citrus Advisor. Sinha was earlier CEO of L&T Mutual Fund.